For the last week or so you have been in discussions with the officers of by a mid-sized client of UCLA Securities that is planning a bond issue. The CEO is concerned that, given the relatively small size of the issue, the bonds are likely to be thinly traded in the aftermarket and that this may deter potential investors. However, she has heard that in some cases investment bankers underwriting an issue have also guaranteed to make a market in the security afterwards. She wonders if including a feature like this in the bond issue under discussion would make sense. Specifically, the in return for payment of an appropriate fee, the investment bank will undertake to continuously quote bid and ask prices, not more than $1.00 apart, at which they are willing to transact.
a) What benefit would the client derive from this arrangement?
b) What disadvantages or costs will result?
c) You recall that you have heard the CEO express the desire to build a stable base of investors with a long-term outlook. Should this objective influence the choice of whether or not to include the market support feature? If so, explain whether it would make the client more or less likely to include the feature.